According to a report published by Transparency Market Research, the global accounting software market is estimated to grow from $5.7 billion in 2017 at nearly 9% annually over the next few years to $11.8 billion by 2026. Xero (ASX: XRO) is a leading player from New Zealand, which is making its presence felt in the industry.

Xero’s Offerings

Wellington-based Xero was founded in 2006 by serial entrepreneur Rod Drury and Craig Walker. Craig Walker had worked at Drury’s earlier software development and consulting company Glazier Systems and was instrumental in spinning a new SaaS company VIATX with Drury. Since founding VIATX, both co-founders had moved onto different projects. In 2006, Walker was working as a consultant CTO for several small businesses and Drury was a Director at New Zealand’s Classified site TradeMe. It was over a social get together that Drury reached out to Walker and asked him to work with him instead to build his new business idea.

Drury wanted to build a new suite of accounting software that would be stored and delivered over the internet for small business use. In 2006, when most business owners were not comfortable with the idea of storing their financial information over the cloud, cloud computing solution was a novel idea. Craig Walker agreed to the business idea and began writing code in his dining room. As the technical framework began to grow, they added three software engineers and three designers to work on the code. They even got the book Accounting for Dummies to help the programmers understand the basic principles of accounting.

Initially, the company was known as Accounting 2.0. But no one involved was happy with the name. The decimal in the name made it difficult to get a domain name as well. Drury wanted a four-letter name and one that would carry significance for an accounting software. They came up with Zero, but the zero.com domain name was being sold for $100,000. A friend suggested going with Xero instead, but Xero.com was a fan site for a music group Linkin Park. After a few rounds of negotiation, the Linkin Park fan was willing to sell the domain for $20,000 and a fully paid business class trip from New York to New Zealand. Thus, Xero was born.

Today, Xero offers a suite of online accounting software for small businesses, accountants, and bookkeepers. Its cloud offering enables users to track and manage cash flow, invoicing, payments, reporting, and pay runs. Xero’s software is available to businesses through a subscription-based model.

Xero’s Platform

As part of its mission to help small businesses, Xero has built a global platform that can help connect millions of small businesses with their third party service providers and advisors. Xero’s platform has access to data from 1.6 million subscribers, 62 million customer connections that account for $2.4 trillion in transactions each year. It has grown to this level by allowing third party developers to build products on their platform that help expand its line up and coverage. For instance, PayStand has integrated with Xero to optimize B2B payments. It offers its users a seamless way to accept payments and reconcile them directly in the accounting software.

Xero’s Platform-as-a-Service strategy looks quite promising. It leverages connections and data sources available within the platform with AI and machine learning capabilities to quickly code and reconcile transactions for small businesses. Its platform delivers integrations with service providers that offer services ranging from inventory management to running payroll. In the long run, its success will depend on how broadly and deeply Xero is able to attract developers onto its platform.

Xero’s Financials

Like everything else, Xero’s financials have also had an interesting story. Being an entrepreneur, Drury had already figured out that he needed NZ$17 million (~$12 million) to sustain a 50 employee company for the three years that they would need to develop the code. He did not want to go to the Silicon Valley or other venture capitalists to raise funds. He believed that in going to the VCs, he would have to sell a big stake in the company. So he decided to list instead and raised NZ$15 million (~$10.3 million) at a valuation of NZ$55 million (~$37.7 million). In 2007, when Xero went public it had no revenues, no product and 1,110 retail investors.

Over the next two years, Xero developed the product and by 2009 it got itself a few local customers. But money was starting to run out. It was then that Drury approached other investors. Today, Xero has raised $681.4 million in funding in the form of debt and through other investors including names like TCV, Accel, Matrix Capital Management, and Valar Ventures.

Xero recently reported its financial results that showed strong revenue growth, but continued losses. For the first six months of fiscal 2019, Xero saw revenues grow 37% over the year to NZ$256.5 million (~$176 million). Losses during the period have grown to NZ$28.6 million (~$19.6 million) compared with NZ$19.6 million (~$13.4 million) reported a year ago.

Xero reported nearly 1.6 million subscribers for the first half of the year. It has 657,000 subscribers in Australia, 324,000 subscribers in New Zealand, 355,000 subscribers in the United Kingdom, 178,000 subscribers in North America, and 65,000 subscribers in the rest of the world.

Xero’s Acquisitions

Xero has been growing its product and market through several acquisitions. In November last year, it announced the acquisition of London-based Instafile. It offered a cloud-based accounts preparation and tax filing solution for UK accountants, bookkeepers, and small businesses and connects them to the UK tax-gathering agency HMRC. Instafile was bootstrapped and was operating with revenues of $1.5 million annually. Xero acquired Instafile for an estimated GBP 5.3 million (~$6.9 million) to make further inroads into the UK market.

Earlier last year, Xero also acquired Toronto, Canada-based Hubdoc for an estimated $70 million. Hubdoc offered a cloud computing and machine learning solution that helped automate financial document collection and processing. Hubdoc had raised CA$6 million (~$4.6 million) prior to the acquisition and had annual revenues of $3.5 million. Hubdoc was already a Xero ecosystem partner. Xero plans on leveraging the acquisition to expand on its platform to help businesses seamlessly connect with their financial data and their accountants and bookkeepers.

Xero is focusing on its platform by acquiring smaller, capital-efficient players that can help it expand in the market while bringing value to its product offering. Entrepreneurs looking to cater to the SMAB market ought to consider Xero as an option to develop upon. For some entrepreneurs, a Bootstrapping to Exit opportunity may also arise.

But it is not alone in the industry. Intuit, for instance, also operates a PaaS strategy and has numerous developers developing services on it. While Xero is definitely a leading player in the Australian and New Zealand markets, it is yet to establish as much of a presence in the North American market. Intuit’s Quickbooks had more than 2.6 million subscribers last year in North America, compared with Xero’s 178,000. Local acquisitions will help it bridge that gap with Quickbooks, but given the lead, it could be quite a while before Xero becomes a force to reckon with in the US. What other companies do you think Xero could look to add to narrow this gap?

Its stock is currently trading at AU$49.21 (~$35.14) with a market capitalization of AU$6.9 billion (~$4.9 billion). It touched a 52-week high of AU$52.57 (~$37.54) in September last year. It has recovered from the year low of AU$30.60 (~$21.85) that it was trading at in March last year.